Antitrust Trouble Through Aggressive Pricing: Let s Count the Ways

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1 Westlaw Journal Antitrust Litigation News and Analysis Legislation Regulation Expert Commentary VOLUME 22, issue 6 / october 2014 Expert Analysis Antitrust Trouble Through Aggressive Pricing: Let s Count the Ways By Steven J. Cernak, Esq. Schiff Hardin LLP Antitrust law wants all competitors even those with high market shares to compete hard. When they do, consumers get the benefits of competition, such as new and innovative products, improved distribution methods and lower costs. One way to compete is through lower prices. Prices can be reduced in many ways, such as by cutting prices, offering discounts to those who agree to buy most or all products from the seller, and providing discounts to customers who agree to purchase bundles of different products. While all these methods would seem to be safe under and perhaps even encouraged by antitrust law, they all have been deemed antitrust violations under certain circumstances. Unfortunately for aggressive competitors, courts and commentators have been unable to agree on what those circumstances are. In fact, U.S. federal antitrust agencies recently held a workshop that illustrated the basic disagreements that exist on these topics among antitrust experts. First, a reminder: To be successful, challenges to all these pricing mechanisms must meet other requirements. Most of these claims assert illegal monopolization under Section 2 of the Sherman Act. 1 Therefore, a plaintiff must show not only that these pricing actions amount to monopolization but also that the company doing the pricing has monopoly power. The most common way to demonstrate monopoly power is to show that the company has a high market share in the properly defined relevant market. While factors such as barriers to entry are also important, courts generally have insisted on market share of at least 50 percent and preferably at least 70 percent before finding monopoly power. 2 These percentages may seem high, but companies must remember that markets are defined with reference to where consumers can reasonably turn for substitutes. As a result, the relevant market often ends up being defined quite narrowly, which can lead to the calculation of a high share. Predatory pricing and other dangerous conduct One of the oldest anti-competitive stories about low prices is that of predatory pricing that is, using extremely low prices to drive out competitors. The U.S. Supreme Court has been skeptical of predatory-pricing claims, calling them rarely tried and even more rarely successful. 3 After all, to be successful, such a predator would need to not only drive out all current competitors but also keep them (and any other entrants) out long enough to increase its prices and recoup its investment. Until any such price increase, such schemes benefit consumers through low prices.

2 As a result, the court has issued a clear and defendant-friendly test for evaluating such claims. In Brooke Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), the court held that to be successful on a predatory-pricing claim, a plaintiff must show that the price is below an appropriate measure of the predator s costs and that the predator is capable of recoupment through later, higher prices. 4 While the Supreme Court has not settled on a single cost measure, many lower courts have required that the low price be below the predator company s average variable cost in other words, very low. In Brooke Group the Supreme Court found no possibility of recoupment because even if the plaintiff competitor left the market, remaining competitors could undercut any attempt to increase prices. Brooke Group has proven to be a clear test for defendants to follow and a difficult test for plaintiffs to meet. On the other hand, the standards used to judge exclusive dealing are much less clear or defendant-friendly. Wait exclusive dealing? Yes. Sometimes non-predatory low prices can be so enticing or tied to other restrictions that decision makers have described them as equivalent to an exclusive dealing agreement. The U.S. Supreme Court has been skeptical of predatorypricing claims, calling them rarely tried and even more rarely successful. For example, the Federal Trade Commission unanimously agreed in In the Matter of McWane Inc. that what the company described as modest short term rebates designed to save jobs were really an exclusive dealing arrangement. 5 McWane Inc. was the only domestic producer of certain pipe fittings. Because some municipal sewer projects required domestic fittings, the FTC found McWane had monopoly power in a narrow market limited to domestic fittings. McWane offered discount rebates to all its distributor customers, but it said that those who also purchased from its competitors including one trying to establish its own U.S. production facilities might have payments of their rebates delayed. Internal and external McWane documents seemed to show that the discounts were meant to drive distributors to purchase all their pipe fittings from McWane and that certainly was the perception of distributors. The FTC commissioners were divided as to whether the discounts were bad for competition. The majority thought they were because the program foreclosed McWane s only domestic competitor from accessing a substantial share of distributors and significantly impaired access to that main channel of distribution. As a result, the competitor could not obtain enough orders to make opening its own domestic foundry efficient. Unfortunately, the majority did not explain what it meant by substantial or significant. It did describe two distributors who chose to buy only from McWane as having a combined total of 50 percent of the appropriate market. While that level is consistent with levels found by other courts to be a key factor in determining when exclusive dealing is anti-competitive, the majority did not explain whether 50 percent foreclosure is necessary for a successful claim. The dissent acknowledged that the level of foreclosure can begin the competitive analysis but said it should not end it. It pointed to the increased market share of the allegedly foreclosed competitor and the lack of output reductions or price increases to conclude that the evidence failed to show the discount program harmed competition. Further guidance is likely to be provided, as the case is currently on appeal to the 11th U.S. Circuit Court of Appeals. 2 october 2014 n volume 22 n issue Thomson Reuters

3 Brooke Group or exclusive dealing? Variations of these two tests Brooke Group s defendant-friendly price-cost test and the more expansive rule-of-reason analysis of exclusive dealing are the main choices for courts evaluating other discount programs, such as loyalty discount programs. Loyalty discount programs offer customers a lower (though above cost) per-unit price if they agree to buy most of their products from one supplier. The 3rd Circuit offered conflicting views on how to address such a program in ZF Meritor v. Eaton Corp. 6 Eaton and ZF Meritor manufacture manual transmissions for large trucks. Eaton offered significant discounts to four truck manufacturers, but only if each agreed to make between 65 percent and 95 percent of its purchases from Eaton for several years. Also, the truck manufacturers were required to prominently feature Eaton transmissions in marketing and ordering materials. Finally, the manufacturers were required to preferential price the transmissions to truck buyers. The 3rd Circuit majority agreed with Eaton that Brooke Group is the applicable standard when price is clearly the predominant method of exclusion. But it also decided that because the nonprice elements of the program contributed to the anti-competitive effects, a full rule-of-reason inquiry was necessary. The appeals court found the discount agreements foreclosed about 85 percent of the market to ZF Meritor. This level of foreclosure was exacerbated by the multi-year length of the deals. The marketing and resale pricing requirements added to the negative effects on ZF Meritor. Finally, the majority found evidence that truck manufacturers feared Eaton would not sell them any transmissions if they did not agree to the discount program. As a result, the majority found that the evidence sufficiently supported a jury verdict in ZF Meritor s favor. Brooke Group has proven to be a clear test for defendants to follow and a difficult test for plaintiffs to meet. The dissent agreed with the majority that Brooke Group is not the correct test if non-price anticompetitive practices are alleged. However, because of the Supreme Court s repeated references to it in other cases, Brooke Group s test should be used by courts as a rebuttable presumption for claims involving price, according to the dissent. The dissent asserted that there was insufficient evidence to overcome that presumption or find Eaton s program was anti-competitive under a full rule-of-reason analysis. The dissent thought the evidence supported neither the 85 percent foreclosure figure nor the allegations of threats by Eaton to cut off supply. It did find evidence that both the marketing and resale pricing program elements were not unusual in the industry and that term of the contract was not that much longer than the term of prior contracts used by both companies. Unfortunately for counselors everywhere, the Supreme Court declined to hear Eaton s appeal. Another discount method that has perplexed courts is bundled pricing. When this method is used, customers receive a discount on product A but only if they also buy products B and C. Competitors that sell only product B can find it difficult to compete with such a program. A federal district court in Pennsylvania recently reviewed such a program on a motion to dismiss in Schuylkill Health Systems v. Cardinal Health 200 LLC. 7 Cardinal and Owens & Minor are two of the largest sellers of dozens of medical-surgical products, including sutures and endomechanical products, known as endo products. Each company allegedly enjoys a 30 percent to 40 percent share of the various product markets. Schuylkill Health Systems is a customer of the defendants. Suture Express sells only sutures and endo products. Allegedly, it was successful before Cardinal and O&M instituted nearly identical bundled discount programs. Under those programs, 2014 Thomson Reuters october 2014 n volume 22 n issue 6 3

4 customers who purchased less than 10 percent of their sutures and endo products from Suture Express or other competitors received one price. Customers who purchased more than 10 percent from Suture Express or other competitors were forced to pay a penalty of between 1 percent and 5 percent on all medical-surgical product purchases. That price penalty allegedly eliminated any potential savings for customers who purchased their sutures and endo products from competitors like Suture Express. Courts and commentators have developed several variations of Brooke Group to analyze the potential anti-competitive effects of bundled discounts. Under the aggregate discount rule, pricing is exclusionary only if the price of the entire bundle is less than its variable cost. Courts and commentators have developed several variations of Brooke Group to analyze the potential competitive effects of bundled discounts. Under the discount attribution rule, the total discount is attributed only to the competitive products sutures and endo products, for example and is compared with the variable costs of those competitive products. Finally, some have simply required that there be a competitor who is at least equally as efficient as the defendant and who could no longer produce profitably because of the pricing program. While Schuylkill Health Systems did allege that Suture Express was equally efficient, the court did not seem to rely on that allegation to deny the defendants motion to dismiss this claim. Instead of discussing any of the standards mentioned above, the court said Schuylkill Health s assertion that customers were forced to pay an enhanced fee if they did not purchase suture and endo products was sufficient. The defendants had no pro-competitive reason for the pricing, and the program inflated prices for all consumers. Even more disconcerting to counselors, perhaps, is that Schuylkill Health s claim was made under Section 1 of the Sherman Act, and not Section 2. While the court cited two monopolization cases involving admitted monopolists in support of its decision to allow the bundling claim to go forward, it did not explain how either defendant could force customers to purchase the bundle if neither company had monopoly power over any of the other medical-surgical products. Exploration, but few answers The U.S. federal antitrust agencies the FTC and the Justice Department s Antitrust Division tried to clear up some of the confusion regarding these pricing practices at a June workshop. Unfortunately, by the end of a long day of presentations, the goal set by commissioner Maureen Ohlhausen determining standards that were predictable, fair and transparent still seemed out of reach. Economists presented only theoretical models that addressed why or when such discounts could harm competition. This is because there are so few real-world studies showing the goals and likely effects of such programs. Attorney presenters debated when a test like Brooke Group should be used and what factors should be part of a more expansive analysis. The workshop provided the antitrust community a better understanding of these common pricing practices, but it did not provide firms and their pricing personnel with a better understanding of when discounts will be found to have harmed competition. So where do these developments leave your clients considering such discount programs? Discounts and prices that are not predatory still are unlikely to run afoul of the antitrust laws. If discounts are implemented by companies with significant market shares and competitors might 4 october 2014 n volume 22 n issue Thomson Reuters

5 be harmed, those discounters are well-advised to be prepared to explain why such discounts will be good for consumers and competition, both now and in the long run. Forcing companies to spend time with lawyers and other experts to develop such rationales might discourage some discounting, which would be bad for competition. Notes 1 15 U.S.C U.S. Anchor Mfg. Co. v. Rule Indus., 7 F.3d 986, 1000 (11th Cir. 1993) ( We have discovered no cases in which a court found the existence of actual monopoly established by a bare majority share of the market. ). 3 Matsushita Elec. Indus. v. Zenith Radio Corp., 475 U.S. 574, 589 (1986). 4 Brooke Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 224 (1993). 5 In the Matter of McWane Inc., Dkt. No. 9351, 2013 WL (F.T.C. May 9, 2013) F.3d 254 (3d Cir. 2012) WL (E.D. Pa. July 30, 2014). Steven J. Cernak is of counsel with Schiff Hardin LLP in Ann Arbor, Mich. He practiced antitrust and trade regulation law at General Motors from 1989 to He also served as lead competition law counsel for GM globally and lead counsel for GM s service operations and fleet operations in the United States Thomson Reuters. This publication was created to provide you with accurate and authoritative information concerning the subject matter covered, however it may not necessarily have been prepared by persons licensed to practice law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice, and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional. For subscription information, please visit www. West.Thomson.com Thomson Reuters october 2014 n volume 22 n issue 6 5